Every year around the March timeframe, I’m do for my annual bonus. It comes through as a lump sum in cash. Historically, I have used it to pay off debts, but today I want to walk through my thought process for what you should do if you were to come across a cash gift. Often times this happens as a result of a bonus, inheritance, pension, or a nice gesture from a close friend/family member. Here is my thought process in order:
Can I use the money to pay off non-tax deductible debt?
There are many tax deductions that are available to many Americans, but are not available to high income individuals. That said, we have one debt that is not tax-deductible. Our rental properties have mortgages that are typically tax-deductible, but for high income earners, the tax deduction for mortgage interest disappears. This will likely be my first choice.
Can I use the money to pay off a high interest debt?
If I did not have non-tax deductible debt, I would look at all other debt and pay off the highest interest rate debt. The way to look at this is to think that you are actually earning the interest rate that you would have otherwise paid on that debt. For instance, if you have a $10,000 car loan at 5%, then paying off that loan would have earned you 5%.
Can I invest the money elsewhere that will earn me more than my highest interest rate loan?
Depending on the interest rate environment, I may forgo paying off a high interest rate loan if I could earn more in another investment or saving vehicle. In a low-interest rate environment, like the one we are in now, it is more difficult to find higher interest rate vehicles. In a high interest rate environment, it is easier to find these types of vehicles (i.e. CDs, money market, savings accounts).
Can I give it away to charity?
We give about 10% of our gross income to charity, including the church, which does a lot to help people less fortunate in our community. Sometimes, it makes sense to look into your own personal finances, your own heart, and give the money to people who need it.
Any other ideas on what to do with a lump sum cash payment/gift?
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